The huge rally in the stock market has helped bring back many investors from the brink of financial ruin. Yet while individual investors have made a lot of progress toward restoring their retirement savings since the bear market, many corporate pension funds are still severely underfunded -- and some are even moving in the wrong direction.
How companies fund pensions
With defined benefit plans -- what most people think of as traditional pensions, which provide a monthly payment to employees after they retire -- your employer is responsible for figuring out how to save and invest enough money to cover its future liability. Unlike Social Security, which can seek revenue from the federal government to make payments to current retirees, companies have to make sure their pension plans have enough assets to meet their current and future obligations.
A recent report from Goldman Sachs illustrates the challenge that corporations faced as a result of the financial crisis. During 2008's market meltdown, many companies saw their pension funds plummet in value. Overall, corporate funding of pension plans among companies in the S&P 500 dropped from 108% at the end of 2007 -- representing overfunded status -- to 79% in 2008.
One would have hoped that with 2009's big rally, those assets would have gained back the ground they lost. Yet the report shows that even though some corporations have indeed made progress in covering their shortfalls, many still have a long way to go. Of the 50 companies Goldman sampled, their 2009 funding levels rose only to 85% -- meaning that pensions made back only about a fifth of their losses from the bear market.
Who's up and who's down
Certainly, the recovery has helped many plans make substantial gains toward 100% funding levels. ExxonMobil (NYSE: XOM), which had the most underfunded plan on the list in 2008, saw its funding level rise 24 percentage points to 74%. JPMorgan Chase (NYSE: JPM) had an even bigger gain of 39 percentage points, moving it from underfunded to overfunded status.
Yet even in the favorable market environment, many companies saw some big slips from last year. Disney (NYSE: DIS) fell from being 94% funded in 2008 to a 2009 funding level of 69%. Deere & Co. (NYSE: DE) saw a drop of 23 percentage points, which dropped it from a comfortable surplus to being only 87% funded in 2009.
What it means
Although these numbers may seem alarming, employees do have some protection. The federal Pension Benefit Guaranty Corporation backstops pension plans up to a monthly maximum.
Yet the PBGC itself has financial problems. According to its annual management report, the PBGC had a deficit of $22 billion as of the end of September, and it only managed a 13.2% return on its investments from the previous year.
Moreover, there's evidence that some companies have taken unfair advantage of PBGC coverage when terminating pension plans. A report from the government's General Accounting Office showed that the sponsors of 10 underfunded pension plans paid 40 executives a total of $350 million in compensation shortly before killing the plans, resulting in employees getting smaller benefits and leaving the PBGC -- and ultimately, taxpayers -- to shoulder much of the shortfall. The report itself didn't name the companies, but independent sources said the companies involved included UAL's (Nasdaq: UAUA) United Airlines, US Airways (NYSE: LCC), and Polaroid.
Watch out
What this means is that companies with underfunded plans may continue to have to make new contributions in order to restore their funding levels. Already, Lockheed Martin (NYSE: LMT) added $1.5 billion to its pension plan in the fourth quarter of 2009 and plans to contribute another $1.4 billion this year. Other companies with underfunded plans will have to make similar contributions to restore funding levels, diverting cash from other uses.
Even with the market's big rise, pension funds have a long way to go before they're back to full health. Until the numbers show better progress, you should pay attention to company annual reports of the stocks you own to make sure you recognize and stay aware of its pension's funding status. And if you're an employee with a pension, you'll want to track not just your employer but also the PBGC's health as well.
If you have a 401(k) instead of a pension, that doesn't mean you're free and clear. Read about why you'll regret a set-it-and-forget-it strategy.
